Sunday, October 2, 2011

The Ph.D. dissertation on Basel II Bank Regulations and their capital requirements for banks that I would like to do.

In November 1999 in an Op-Ed in the Daily Journal of Caracas I wrote “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse, of the only remaining bank in the world” And indeed, in 2007-08, one Big Bang occurred… in my opinion as a direct result of Basel II. 

I would now like to do a Ph.D. dissertation on the subject of how the capital requirements for banks of Basel II and which based on the regulators’ fixation with the ex-ante perceived risks of default, introduced serious distortions in the financial markets that caused the current bank and financial crisis. 

Banks lend to clients adjusting the interest rates they charge, the amounts they lend, the duration of the loans, and the scrutiny they give the borrowers, to what they perceived is the risk of non-payment, a perception which obviously includes the information provided by the credit rating agencies. 

But when bank regulators introduced capital requirements for banks that were also based on the ex-ante perceived risk of default, these allowed the banks to hold much less equity when lending to those perceived as “not-risky” than when lending to the “risky”. 

That resulted in that banks were then allowed to leverage their equity much more with the risk-adjusted interest rates when lending to the “not-risky” than what they can do when lending to the “risky”. 

And that in its turn resulted in that banks could earn much higher returns on their equity, ROE, when lending to the “not-risky”, like the “solid” sovereigns and triple-A rated private borrowers, than when lending to the “risky”, like the not-so-solid sovereigns, small businesses and entrepreneurs; and or, that the interest spread between the “not-risky” and the “risky” widened considerably. The “not-risky” are charged lower interest rates than what they would be charged in the market absent these regulations, and, vice-versa, the “risky” are charged higher interest rates than what would otherwise been the case. 

These capital requirements do nothing to reduce the risks of a bank crisis, as these have always occurred because of excessive bank exposure to what had erroneously been perceived ex-ante as not risky; while at the same time they dangerously discriminate against some of the most important and dynamic participants in an economy. 

In this respect these capital requirements stimulated the creation of excessive bank exposures to sovereigns and triple-A rated, that which detonated the crisis; and they are also, by making it harder for small businesses and entrepreneurs to access bank credit at competitive rates, hindering the economy from getting out of the crisis. 

The above thesis could be demonstrated through research analyzing how the interest rate spreads between bank exposures to the “not- risky” and the “risky”, the leverage of the banks and the ROE has responded to the changes in the capital requirements. 

Some capital requirements for banks that discriminated for risk were already in existence as a result of Basel I, but the most extensive use of it came with Basel II, which was approved by the G10 countries in June of 2004. Therefore analyzing and comparing in some detail the two years of banking previous to June 2004 with the two years of banking thereafter should yield quite conclusive evidence as to who are to blame. 

Had the regulators not with a certain degree of hubris assumed the role of risk-managers for the world, arbitrarily toying around with their risk-weights, then quite probably another type of crisis could have ensued, as a result of many existing macro-economic disequilibrium, but none as severe, systemic and destructive as the current one. Just for a starter the demand for AAA rated securities backed by mortgages awarded to the subprime sector, would not have been a fraction of what it ended up to be. Just for a follow up, European banks would never ever have loaded up so much on the sovereign debt of Greece.

Now what I need to find is the university and the professors willing to give my thesis a chance, hopefully close to Washington D.C. where I currently reside, though these days I guess much of it could be done through the web too. 

Is there anyone out there willing to lend me their support?

PS. If you allow me here is a video that explains a small part of the craziness of our bank regulations, in an apolitical red and blue!